The Hindu Business Line : RBI study on FDI — Raises questions on quality of growth

It is rightly preferred to debt flows because, apparently, it does not create servicing obligations. While this is true to a limited extent, in that it does not increase interest costs and amortisation liabilities, there is still an indirect cost in the shape of increasing dividend remittances and import intensity.

It is, therefore, important that even as we pursue the goal of higher FDI, we should study the actual performance of FDI industries in the economy and draw the right policy lesson.

Time was when leading economists in the Government were particularly perturbed over the possibility that foreign investors would take advantage of higher import tariffs, which created protectionist walls in the country. This was expected to happen in the following way.

Foreign investors would derive advantage by producing goods inside the host country at protected margins, thanks to import tariffs.

This phenomenon was vaguely captured by the phrase "tariff jumping". The argument was that it does not do good to any economy to encourage foreign direct investment for enhancing production in sectors that enjoy high tariff protection.

The foreign manufacturer, in effect, jumps the tariff wall by shifting production to the importing country.

A low tariff environment and open trading system are the prescribed ways out to gain maximum advantage from foreign direct investment.

It is one of the oft-stated gains of FDI that it increases exports, as in China. Whether there is a net foreign exchange earning as a result of FDI depends, however, on the import intensity of these exports.

FDI units, particularly in the automobile sector, tend to tie their manufacturing process to imports of components.

Hence, the higher exports may not translate into equally high forex earnings, unless the investor sets up local units to produce components.

This is a slow process. Also, the transfer of dividends and profits in general ultimately reduces the forex gain factor of FDI.

These are some of the aspects we have to bear in mind while analysing the performance of industries involving FDI.

The RBI's latest (December 2003) bulletin contains a useful study of FDI companies for the year 2001-02. This piece attempts to interpret the results of this study from the broad background of FDI's macro-economic impact.

The RBI study is of 465 companies, which are culled from the regular RBI study of non-government non-financial public/private limited companies. Of these, 288 are public limited and the remaining are private limited.

The RBI experts could have indicated what percentage of the total universe of FDI companies in India is covered by the studied sample, in terms of invested capital or sales or both, to make the information useful from the point of view of analysts. As it is, we have to take it for granted that the study is a representative sample.

The total net forex inflow or outflow of the studied companies is an interesting statistic. The study shows that for all the studied companies, this figure was negative in the year 1999-2000 and became positive only in the years 2000-01 and 2001-02.

It is good that the trend is positive. While these industries have become net contributors of forex recently, the high import intensity of their manufacture is worrying. Table 1 shows the trend of these inflows and outflows in selected FDI industries.

There is no discernible pattern in these figures. However, some of the figures stand out. The high intensity of imports to exports of the automobile-related industry is disturbing. It is perhaps explained by the presence of CBU (completely built-up units) in the industry.

The existence of a high ratio of imports to exports in wholesale and retail trade should also be explicable in terms of India acting as a re-export hub. But the figures need some explanation.

The relatively low figures in computer and related sectors are perhaps because of value addition.

The RBI study would have been more helpful for policy-making if it had attempted a broad analysis of the different figures thrown up by the study.

The data regarding export intensity of sales of the selected FDI units (Table 2) does not also convey any significant information in favour of FDI as an export enhancer.

These figures also need further analysis. The hype about FDI encouraging exports is not fully borne out, especially if you see the low figures in respect of some industries.

Our surmise regarding re-export explaining the high import-export ratio for wholesale and retail trade also stands discredited by the low export sale ratio. All in all, the figures should be supported by a much more purposeful analysis of trends.

I have given above only an illustrative example to show that the net impact of FDI companies depends very much on the structure of industrial and tariff policy.

The structure of production that obtains in China seems to be more designed to increase the contribution of FDI companies to forex earnings.

The other advantages that FDI brings will, of course, be cited as qualitative defences of policies encouraging FDI. These include technology, markets and increased employment. But ultimately we have to go by the benchmark of how much FDI increases exports and forex earnings in the net because the investment creates liabilities.

The RBI study would have been more useful for analytical purposes if it had indicated the capital invested in the studied companies in terms of forex expended and the profits earned converted into forex at the current point of time as percentage of equity.

The figures given are in terms of rupees of profits earned in relation to the equity also converted into rupees. It is not clear whether the conversion is at current exchange rates or historical rates. The study should, in my opinion, be restructured to be of use to policy analysis.

Subject to these limitations, the information conveyed by the study is nonetheless informative. It carries a few important lessons, which go to show that FDI is not all that positive, at least in certain sectors, particularly the automotive sector. The return on equity of FDI companies (Table 3) shows a wide variation. The figures are revealing. The high returns on food products and beverages show the marketing advantages and almost monopolistic power of some of the soft drink majors.

The low return on equity in some cases may also reflect transfer-pricing policies by which the investor transfers more income to a tax-effective point of origination. An analytical presentation of returns derived in the country of origin of the investment for similar industries would have helped.

The study of FDI published by RBI cannot answer all questions. But it does raise some. Whether FDI adds to net inflow of forex or leads to a drain of forex has to be studied. Policies have to be designed to counter the deleterious implications. The framework of policies has of needs to fit in with our agreements with WTO.

The overall macro-economic imperatives have to be kept in mind. Market-oriented correctives in terms of more competition and technological openness should be examined and implemented lest we fall a victim to the apparently higher growth without compensating export growth or rise of productivity.

The FIPB has its hands full in terms of bettering the Chinese record in terms of the magnitude of FDI into the country. We have also to ensure that the quality of FDI is appropriate.

While selectivity in admitting FDI is costly in terms of procedural hassles, selective inducements for FDI which enhance exports and our competitive strength can always be designed. This is the challenge for industrial policy.

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